Regulatory push continues

There seems to be no let up from the tidal wave of international legislation in the pipeline this year from both sides of the Atlantic, targeting the financial services industry.

Senators Carl Levin and Kent Conrad’s newly passed Highways Tax Bill and the Foreign Account Tax Compliance Act (FATCA) are the two most notable recent pieces of US legislature on which Cayman’s financial services industry will be focusing, as well as the European Commission’s proposed Directive on Alternative Investment Fund Managers for which the Commission is expected to adopt implementing measures this year. While Cayman’s regulatory framework remains robust and its financial services industry stable, the added layers of complexity to ensure compliance with the myriad of new laws will undoubtedly cause institutions here in Cayman to take a fresh new look at their ability to comply.

On 14 March, the United States Senate passed, on a bipartisan basis, the Highways Tax Bill which paved the way for an extension of America’s existing highway-related taxes, as well as the funding of infrastructural spending by the US Federal Highway Trust Fund.

The Bill also included an amendment to the original Stop Tax Haven Abuse Bill which gives the US Treasury Department the authority to take measures against foreign governments and financial institutions that they believe significantly impede United States tax enforcement.

Such measures were urgently pushed through the US Senate because existing transport-related taxes were about to expire which could have led to transport and highway projects in America coming to a grinding halt. Those pushing through the amendment anticipated that the amendment giving the Treasury extra powers would help to net the US Government around US$1 billion over ten years in additional revenue to fund their highway projects.

The Bill, championed by Senators Levin and Conrad, would give the US Treasury a new set of tools to combat foreign governments or financial institutions that it believed impeded US tax enforcement.

In his statement to the US Senate introducing the amendment, Levin said: “Under the Patriot Act, Congress gave the Treasury the power to take a range of measures against foreign financial institutions or jurisdictions that it finds to be of “primary money laundering concern”. The Levin-Conrad amendment would authorise Treasury to impose the same types of measures on the same types of entities if Treasury finds them to be “significantly impeding US tax enforcement”.

The US Treasury could prohibit US banks from accepting wire transfers or honouring credit cards from banks found to significantly hamper US tax enforcement efforts for jurisdictions which they believed were “tax havens”.

While Cayman’s financial institutions will be getting to grips with the possible impacts of such proposals, should they become law (the Bill now has to pass the House of Representatives), it should be noted that the language of Senators Levin and Conrad’s amendment is now more positive than it was in the Bill’s original format. Instead of focusing on financial institutions or foreign jurisdictions that impede US tax enforcement, it now addresses financial institutions or foreign jurisdictions that significantly impede US tax enforcement. It also expressly provides that institutions or jurisdictions that are cooperating on FATCA should be viewed more favourably.

“The fact that a jurisdiction or financial institution is cooperating with the United States on implementing the requirements specified in chapter 4 of the Internal Revenue Code of 1986 may be favourably considered in evaluating whether such jurisdiction or financial institution is significantly impeding United States tax enforcement,” the amendment states.

Never-the-less, the revised amendment would authorise the US Treasury Department to bar foreign financial institutions from access to the US financial system if these foreign financial institutions or the foreign jurisdictions in which they operate are found to be impeding US tax enforcement.

The amendment is patterned after the Patriot Act’s grant of authority to the US Treasury Department to block money launders and would authorise Treasury to prohibit (or impose conditions) on US banks from opening or maintaining a correspondent account or “payable through” account or processing credit card transactions from foreign financial institutions if Treasury determines that the institution or the foreign jurisdiction in which the institution operates is impeding US tax enforcement.

Thus Cayman’s financial institutions will need to carefully assess the impact on their business, should the Bill become law.

Cayman had a robust regulatory framework in place with tax information exchange agreements in place with 27 countries (including the United States, which was signed in November 2001); however it will be important to follow the exact nature of these new proposed requirements as they unfold.

The facts on FATCA

On 8 February, 2012 the United States Treasury and Internal Revenue Service released proposed regulations for the Foreign Account Tax Compliance Act (FATCA). Under FATCA, US taxpayers with specified foreign financial assets that exceed certain thresholds must report those assets to the IRS via an additional form that taxpayers should attach to their federal income tax return, starting this tax filing season. If they don’t, they will be liable for a 30 per cent levy on interest, dividends and proceeds from US assets.

In addition, FATCA will require foreign financial institutions (FFIs) to report directly to the IRS information about financial accounts held by US taxpayers, or held by foreign entities in which US taxpayers hold a substantial ownership interest.

In January 2013 US withholding agents must ensure their new customer process is FATCA-compliant and by 2014 foreign financial institutions (FFIs) must do the same. This timeline means that financial institutions must now get to grips with implementing fully-fledged FATCA programmes.

In the main, discussions on the effects of FATCA have focused on banks, but custodians, investment vehicles and insurance companies will also be required to meet the requirements of the IRS.

In order to comply with these new requirements, financial services institutions will need to focus on classifying existing clients, and enhancing systems for new customers and new counterparties.Due diligence that will need to be performed will include electronic searches on all accounts holding over US$50,000, and paper reviews on all accounts holding over U$1 million.

More specifically, financial institutions in Cayman are advised to conduct a detailed analysis of their existing customer base to ensure that any US clients are correctly identified as American and are reported to the IRS. Systems should be implemented that will automatically capture additional documentation on new customers when they set up an account. In addition, it is suggested that systems are also created which would withhold the 30 per cent levy on customers who refuse to supply the information and documentation required.

Overall, it is anticipated that most financial institutions in Cayman will need to make significant changes to their business practices over the next several years, including adapting their people, process, technology and internal governance systems to handle the increase of due diligence procedures and thereby comply with FATCA regulations.

A Herculean task

In a recent report, The Economist said that the FATCA rule would also apply to company pension funds “even though it seems unlikely that many Americans would go to the lengths of joining corporate pension schemes to evade taxes”.

“Pension funds will have to assert not only that their members are not Americans but that their potential beneficiaries (spouses, children) are not so either, a Herculean task,” The Economist said.

It continued: “If the process is not made simpler or less costly, fund managers may be forced to take drastic measures. One approach would be to bar Americans from investing in their funds, or to require them to own separate classes of shares. Another approach would involve some global funds avoiding American assets entirely. That can hardly be what Congress had in mind.”

For Cayman’s part, Premier McKeeva Bush stated at a seminar held at the end of January of this year to assist US citizens residing in the Cayman Islands with FATCA compliance that he would be taking a second trip to Washington this year to put Cayman’s case to legislators.

Premier Bush said: “On 27 March last year I led a delegation to Washington to discuss matters of mutual interest and concerns involving the implementation of FATCA provisions with senior officials of the IRS and the US Treasury.

Most importantly, through our dialogue with the IRS we have been assured that whatever system that is employed by the US will be fair and that the Cayman Islands and US dual citizens will not be given less preferential treatment than any other person.”

The Premier went on to say that in the very near future he would be speaking more about the government’s efforts to meet with the IRS and if these efforts to meet had potentially impacted FATCA requirements.

“It is important to note that several of the points we had raised with the IRS seem to have been taken into careful consideration,” he confirmed.

“The IRS has heard the voice of the islands and the Government and we are fully prepared to engage them in another round of discussions and show them that we are country committed to excellence, integrity and transparency and a fully compliant jurisdiction.”

EC Directive moves forward in 2012

Finally, the European Commission’s proposed a Directive on Alternative Investment Fund Managers (AIFMs), first introduced in April 2009, will commence implementation this year. Developed with the objective of creating a comprehensive and effective regulatory and supervisory framework for AIFMs at the European level, the Directive was aimed at providing harmonised regulatory standards for all AIFMs. The final agreement on the framework Directive (Level I) was achieved in November 2010 and the text entered into force on 21 July 2011.

According to the Alternative Investment Management Association (AIMA), the European Securities and Markets Authority (ESMA) was requested by the Commission to provide technical advice on the implementing measures of the AIFMD (Level 2).

ESMA’s final technical advice was submitted to the Commission on 16 November 2011 and the Commission is expected to adopt implementing measures based on ESMA’s advice in the course of 2012. Member States will then have until July 2013 to transpose the Directive and its implementing measures.

Continuing with efforts to undertake dialogue with regulatory bodies, vigilance when it comes to new legislation proposals and a strong private/public sector partnership will ensure that Cayman continues to weather these latest regulatory pushes and remain a vital cog in the wheels of the global economy.